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March 1, 2013

Time for Market to Show Its True Mettle—Searching for Alpha for March 2013

Economic crosscurrents have finally caught up to the market. Just this week alone, Italy’s election woes, the sequestration and a paltry fourth quarter GDP report has made believing in the equity rally a little tougher.

A quick glance at the fundamentals show that for every reason to own stocks there is an argument to sell them:

Earnings have risen, but coming public austerity in the U.S. could put an end to further expansion

Companies are in good fiscal shape, but a slowdown in consumer spending is problematic

Housing starts are impressive, but employment growth is still paltry

So what’s an investor to do, and what's an advisor tell clients? First off, it’s important to have a long-term view. Mine is bullish, and based mainly on valuation. The forward P/E for the S&P 500 is around 13, which is below the previous two peaks in March 2000 (P/E was 27) and October 2007 (P/E was 15). And since earnings are higher now than they were then, that should give the market some wriggle room. We might have some short-term weakness, but it’s important not to let one’s market exposure (beta) dip during portfolio rebalances or redeployments.

Further, stocks have a competitive advantage versus other asset classes. They are not widely owned, yet the supply is shrinking due to M&/A activity (which, in turn, is being fed by lower rates). Dividend yields are comparable to short-term bonds, but the upside for equities is much greater.

The bulk of wealth created in the U.S. is due to investor participation in the growth of the economy. Don’t get waylaid by commentators looking for a short-term dip—remember, bad news sells much better than good news. Now is the time to draw a line in the sand and stay invested.

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